Overpaying Employees

Paying Employees Too Much? How To Deal with an Expensive EmployeeI’m actually surprised at how often people ask the question: “What do we do when we find out we are paying people too much?” To answer that question you first need to ask yourself two important questions: 1) Have I properly defined the market for this position? 2) What type of performer is this employee? Paying employees too much is not something that most companies focused on becoming or remaining profitable for a long time can do without merit. Certainly, if the employee is a super star, you probably can afford to pay extra. But if they aren’t, it’s best to reign the spending in. This type of pay practice can actually put you out of business.

April 29, 2010

Paying Employees Too Much? How To Deal with an Expensive Employee

I’m actually surprised at how often people ask the question: “What do we do when we find out we are paying people too much?” To answer that question you first need to ask yourself two important questions: 1) Have I properly defined the market for this position? 2) What type of performer is this employee? Paying employees too much is not something that most companies focused on becoming or remaining profitable for a long time can do without merit. Certainly, if the employee is a super star, you probably can afford to pay extra. But if they aren’t, it’s best to reign the spending in. This type of pay practice can actually put you out of business.

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First, let’s talk about making sure you have properly defined your market.

1. Market compensation data comes in many different “cuts.” When using your market tools, you want to be careful about which “cut” of the data you are using. Compensation is greatly impacted by industry, size, geography and even a company’s annual sales. When comparing yourself to other companies and what they pay, you want to make sure that you are comparing to companies similar to yours, or if you are not, that you have intentionally chosen to compare yourself to a different competitive set. For more information, see the blog post “Determining Salary Range Widths by Profession.”

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2. Where you are relative to the market is all about your company’s compensation philosophy. It’s not okay to set your midpoints to the average if your company has a competitive philosophy of leading the market. It’s also not a good idea to set your salary midpoints or your targets to the average if you have a rich benefits package that is meant to balance a lower cash compensation target. So, in determining if you are paying at the market you also have to take in to consideration where your company wants to be relative to the market. Paying too much does not mean more than the average if your company has a “lead the market” pay philosophy.

3. The market moves. It’s important to have updated compensation data. Don’t assume that you are paying too much if you are using outdated salary information. Even though the overall economy seems to be suffering, many industries and many different positions are booming. Using outdated compensation data can give a skewed view of the market. Positions in healthcare, IT and accounting have been moving year over year far more than the standard increase across all positions in all industries. Before you make any statements about paying too much, make sure you know the current market rates and stay informed of those positions that are in great demand. Often times, these jobs are paying at the 75th and 90th percentile.

Once you have established that you have reliable market data and you discover you really are paying too much for the individual in that position, you must then determine if this is an issue based on performance. How you treat this situation will be based largely on what the person is worth to the company.

1. If the employee is a low performer it’s pretty easy to know what to do. Get rid of them. All of my HR training will tell you though, that exiting an employee is not quite that easy. First of all, you want to make sure that the manager has made efforts to notify and inform the employee about their sub-standard performance and has made attempts to help the employee meet performance standards. But if these efforts have resulted in continuous bad performance and the employee is overpaid relative to the market, you owe it to the organization to exit that employee. Exiting the employee after continuous attempt to help them develop into an acceptable performing employee is really your only option.

2. If the employee is an acceptable performer, but you wouldn’t lose sleep if they left, then your strategy will be slightly different. First, the same questions apply: Do they know that they are only an acceptable performer and do they clearly understand what great performance looks like? If so, then the job of the manager/organization is to freeze pay until their performance has reached levels that we would want to reward. See our blog post on creating a red circle policy “HR Cost Cutting with a Red Circle Policy.” There is no reason to give someone who is only meeting expectations more money just because they have been with the organization one more year. If their performance is not above average then there is no reason for their pay to be above average.

3. If the overpaid employee is a super star, one of those employees that you would lose sleep over if they left, and they are overpaid relative to the market, you may want to adopt an entirely different strategy. In this case, you may not want to limit the employee’s earning potential, but rather find a better way to give it to them than just a larger base salary. This approach can include creative incentive plans that are designed to reinforce their stellar performance. For example, you could give the employee more frequent, unpredictable bonuses to recognize achievement. This method can actually have more bang for the buck than just more base salary. Another option is to look for opportunities to help this employee grow to the next level. If there is a higher level position that they can work towards, then eventually they won’t appear to be overpaid. Help this employee gain the skills necessary to become a manager or a senior director or get ready to take over an executive position.

I hope that this information can help you and your organization make smart decisions about your compensation expenses. Remember, smart compensation design can actually help reinforce performance and drive better business results. But, if you are spending money unnecessarily on people who haven’t earned it, it will be hard to achieve results or reinforce your company’s commitment to rewarding performance.

Are you doing a salary review or compensation benchmarking project? PayScale provides up-to-date, external salary market data you can use right now. And, it is specific to the education, skills set and experience your employees. Give a PayScale demo a try.

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